Post-2012 Climate: Getting the incentive mechanisms right

While well intentioned, some of the key policy mechanisms introduced under the existing Kyoto Protocol failed to encourage the level of investment in clean energy development required to stem climate change. In Copenhagen next month, global leaders need to get it right.

A global agreement on aggressive emissions reduction targets combined with new and expanded carbon market mechanisms for a post-2012 climate is what Steve Sawyer, secretary general of the Global Wind Energy Council, is hoping will be the result when world leaders meet in Copenhagen next month for the United Nations Framework Convention on Climate Change's Conference of the Parties (COP 15) negotiations (see page 57). While still criticised for underestimating the potential for wind power (previous story), it is a view the International Energy Agency (IEA) agrees with. An international agreement needs to be reached on "a realistic combination" of cap-and-trade, sectoral agreements and national policies tailored to each country's circumstances, the IEA says.

In its World Energy Outlook 2009 climate change excerpt, published last month, the IEA assumes that in its most advanced scenario for a post-2012 climate change framework all Organisation for Economic Co-operation and Development (OECD) countries will have national commitments and mitigation policies, including a cap-and-trade system for power generation and industry. It assumes that other countries will reduce emissions through "nationally appropriate" mitigation actions, with international finance and technical support. All regions will participate in sectoral agreements for cement, iron and steel, passenger vehicles, aviation and shipping that establish emissions intensity targets (for example, emissions per tonne of steel), it says. It adds that, after 2020, other major, non-OECD, economies are assumed to be part of the cap-and-trade system in power generation and industry.

The IEA believes carbon will be traded in two separate markets initially - one covering the OECD countries and one for the other major economies. To ensure emissions are contained sufficiently, it estimates the price of carbon to reach $50 per tonne in 2020 in the OECD market, rising to $110 in 2030. In the other major economies market, it estimates the price to reach $65 in 2030, it adds. Overall, IEA calls for an "ambitious, robust global agreement in Copenhagen, which will credibly deliver substantial emissions abatement, with financial and technology support to ensure that all regions contribute".

This should, it stresses, include "an expanded, reformed" clean development mechanism (CDM), something most commentators, including those in the wind industry, agree on. CDM (see graph overleaf) has been a key mechanism for funding projects under the Kyoto Protocol. It enables industrialised countries to invest in projects that reduce emissions in developing countries as an alternative to more costly emissions reductions in their own countries. But aside from China and India, wind project development via the mechanism has been few and far between. And, due to complex and often misinterpreted additionality requirements to prove that the emissions savings generated from a project would not have been achieved otherwise, CDM has been accused of actually preventing some governments in developing countries from introducing strong domestic renewables legislation at all (Windpower Monthly, October 2007). To stimulate large-scale clean energy generation in developing countries, the CDM must be broadened beyond single projects to become a positive incentive for governments to implement climate-friendly policies, the wind industry has long argued.

In line with that, the most touted form of reform has been for the introduction of a CDM-type mechanism based on sectoral agreements for emissions reductions from electricity generation, in place of the current project-by-project mechanism, although views on exactly how this may work differ. Conceptually, most commentators suggest it would essentially mean treating an entire sector in a developing country as a CDM project with companies or organisations from developed countries still essentially funding projects in developing countries.

Voluntary target

The wind industry, Greenpeace and others propose setting a voluntary sectoral no-lose target (SNLT) for each developing country that goes beyond a business-as-usual emissions profile, coupled with a sectoral crediting mechanism (SCM). It would be no-lose in that no compliance penalties would be incurred if the planned reductions are not achieved. Reductions below the SNLT would generate emissions reduction credits, with each credit representing a tonne of carbon saved. Credits could then be traded on the international carbon market. "Both the mitigation and carbon finance potential from employing a SMLT/SCM mechanism could be very large, much larger than the current arrangements, and it could have significant advantages for developing countries seeking to attract finance, technology and capacity building to meet their own sustainable development goals," say GWEC and Greenpeace in a discussion paper presented a year ago at COP 14 in Poznan, Poland. "While well short of economy-wide emissions caps for industrialising countries, it provides measurable global CO2 emissions reductions and should stimulate fundamental structural change in the electricity system of countries who participate."

Meantime, rather than just providing a percentage point or two to the rate of return of individual projects, SNLT would give developers the confidence to develop a pipeline of projects for low carbon technologies. And any country with substantial emissions from the electricity sector could participate and attract carbon finance, "providing for a more equitable distribution of carbon investment throughout the developing world". Significantly, "there would be no need for complex and expensive additionality considerations". The GWEC/Greenpeace report also strongly recommends that the SNLT should be established with reference to both emissions intensity and absolute emissions rather than purely on an intensity basis, as some argue. "Energy efficiency measures would not need to be bundled into projects, but would be incentivised across not only the power generation sector but throughout the economy, thus ensuring a built-in incentive to drive the efficiency measures needed to reduce demand growth, which will be a critical part of achieving emissions reductions in the power sector," it says.

The IEA has also backed the idea of sectoral market mechanisms as a key driver for clean power generation in developing countries, calling it a radical departure from the current CDM in its September publication, Sectoral Approaches in Electricity - Building Bridges to a Safe Climate. To be politically plausible, it says crediting on a sectoral basis will require setting ambitious emissions targets to deliver global carbon emissions abatement and ensure the supply of credits does not overwhelm demand. It notes, though, that an agreement to a target at sectoral level will not be enough to drive change at plant level, so the carbon finance community "must start working with electricity policy makers in developing countries to determine how sectoral mechanisms can effectively send a carbon price signal to investors in power generation". Again under the IEA's proposal for sectoral crediting, carbon credits would be issued for performance aggregated at country level.

While acknowledging that it may not be politically attractive for many developing countries, IEA suggests the introduction of domestic cap-and-trade systems could be the means to exceed the sectoral target. "An enforceable cap on emissions, with emission allowances to domestic sources and a price on carbon, would encourage change at the level of individual sources," it says. "These domestic systems could pave the way for a global carbon price in the future, via linking of regional emissions trading systems." Within the sectoral approach, IEA continues, technology deployment goals are also proposed as commitments for which developing countries could seek international assistance, and which could contribute to meeting a sector emissions target. Meantime, all agree that to be politically acceptable and workable, targets for developing countries must be established via an internationally agreed methodology and take into account other aspects of the post-2012 agreement, such as technology and capacity-building arrangements.

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